Islamic finance encompasses a broad range of financial products that are structured in compliance with Islamic law (Shariah). There are, however, diverging views amongst scholars and Ulama on the type of transactions that are permissible as Shariah compliant. Islamic finance in Nigeria is provided by a few niche lenders.
Principles of Islamic finance
The general principles of Islamic finance include the prohibition of usury or interest (riba), excessive uncertainty (gharar) and gambling (maysir), as well as risk and profit sharing between involved partners. Additionally, assets and investments can only come from, and be made in, Shariah compliant activities, and transactions must be backed by tangible, identifiable underlying assets. All financial institutions offering Islamic financial products and services must also be supervised by a Shariah Supervisory Board.
All sharia transactions have to be approved by a board of scholars. There are many such boards around the world but they do not all adopt the same approach. This is because sharia law is, like any system of law based on religious principles, a matter of doctrinal interpretation.
The ban on riba – the raising of an interest charge that doesn’t vary despite fluctuations in the value of the underlying asset – complements a ban on speculation (gharar literally `deception). This rules out highly-leveraged debt, derivatives for speculation, insurance and gambling. It follows that Islamic banks don’t get involved in the money markets and wouldn’t have touched sub-prime although, interestingly, asset-backed securitizations (because they are based on real, tangible assets – an important principle in Islamic banking) are acceptable as are a form of asset-backed bond called sukuk. In fact sharia-based principles may appeal to ethical investors who aren’t muslim since investments in alcohol, munitions, tobacco and casinos, amongst others, are not permitted.
Islamic finance is more akin to asset finance. Islamic banks don’t make loans but fund assets for customers by buying the asset then (simultaneously or at a later date) selling the asset to the customer for payment at a later date with a mark-up, which is the bank’s return. This mark-up or service charge is called murabaha. There is in fact a finance leasing equivalent called ijara where the asset is funded by selling a rental participation to the investor who effectively buys a share in the underlying asset, with the rental return pegged to a benchmark. Hire purchase is ijara wa-iktina. Project financing is achieved through istisna-ijara financing(istisna is a form of deferred vendor financing where the seller provides the loan).
The underlying concept is one of the sharing of risk with the attendant sharing of profit. It follows that there isn’t the equivalent of the general purpose loan where a company borrows the money without specifying what it will use it for. Instead this is special-purpose funding where the amount in question is applied to a specific purpose. Sukuk securities act as securitizations, backed by an underlying asset in respect of which a return or cash flow is generated. The sukuk holder has a share in the underlying asset, receives an income from the asset and shares the responsibility for its maintenance.
Islamic finance in Nigeria
Home to a significant portion of the Muslim population in West Africa, Nigeria features a potentially strong demand for Islamic financial services and products, presenting significant opportunities to deepen and broaden financial intermediation. While still comparatively underdeveloped, Islamic finance is expanding in northern part of the country.
Assets in established Islamic markets such as Egypt and Sudan reached USD 6.3billion and USD7.2billion respectively by end-2008, while Nigeria has stated intentions to develop our market into Islamic financial hubs for the continent.
Islamic banking, a banking system that is based on the principles of Shariah and obeying two basic principles which are the sharing of profit and loss and the prohibition of the collection and payment of interest; largely dominate Islamic financial systems Holding almost 75 percent of global Islamic assets worldwide in 2008. Fully-fledged Islamic banks and commercial banks with Shariah compliant windows represent the most important source of Islamic investments and form the majority of Islamic financial service providers across Africa.
Takaful and retakaful represent forms of Islamic insurance and re-insurance based on principles of mutual assistance, burden-sharing and joint guarantees. Global takaful contributions reached an estimated USD 7 billion in 2009. While the number of African takaful companies is still limited, gross takaful contributions across the continent have exhibited an 18 percent compound annual growth rate (CAGR) between 2005 and 2008, and increased by 26 percent in 2009 to reach an estimated USD 377 million.
Islamic Capital Markets
Islamic Capital Markets have significantly expanded following the development of Islamic finance instruments and Islamic accounting standards and regulatory bodies. While the principles of gharar and maysir largely prohibit trades in most types of derivatives, Islamic Capital markets are becoming increasingly sophisticated platforms for companies to raise Shariah compliant funds.
The global market for Sukuk, Islamic financial certificates similar to bonds and asset-backed certificates, has expanded rapidly in response to increasing demand from IFIs and individual investors for Shariah compliant equity. Malaysia is the biggest sukuk market in the world with 39% of sukuk outstanding or equivalent to USD80.2 billion, with 825 issues (2009), The London Stock Exchange’s sukuk market is the largest in Europe. In accordance with the prohibition of ribah, sukuk are structured to not generate interest, but rather place the assets that back the sukuk into a special purpose vehicle (SPV) that provide returns based on concrete transactions. By end-2009 cumulative total global sukuk issues topped USD24.6 billion. Sukuk markets in Africa are still very limited with sukuk issuance in very few countries, such as Sudan and The Gambia, while others such as Egypt have announced plans to further develop domestic sukuk markets in the future.
Islamic Investment banks and Islamic Investment Funds are becoming increasingly active investors on global markets. Often adopting structures similar to that of mutual funds, equity funds, leasing funds and commodity funds, Islamic funds aim to generate profits from large scale investment pooling, underwriting and market-making activities.
Islamic Microfinance offers the potential to significantly expand access to finance, particularly to poor and unbanked households which do not use conventional microfinance services for religious reasons. While limited publicly available data makes assessing the state of Islamic microfinance in Africa difficult, a CGAP survey Islamic MFIs had a global outreach of only about 380,000 clients, representing about 0.5 percent of total microfinance outreach at the time, there was a large unmet demand for Islamic microfinance products indicating a strong growth potential for the sector.
International Islamic finance
A fifth of the world’s population is Muslim and less than one in a hundred securities is sharia-compliant, the scope for growth is huge. Islamic banks have been around for over 30 years (Dubai Islamic bank which began in 1975 is thought to have been the first), they are present in over 75 countries and the annual rate of growth has topped 10% for a number of years.
While Islamic finance accounts, as of 2010, for only about 1 percent of global financial assets, it represents one of the fastest growing segments of the international financial system, with an annual growth rate exceeding 20 percent over the past decade. Islamic assets stood at USD 1 trillion in 2010 and are expected to reach USD1.6 trillion in 2012. These assets span a broad range of financial activities, products and services, ranging from personal and corporate banking to insurance, capital market securities, investment funds and microfinance.
There are sharia-compliant derivatives and hedge funds on the basis that more liberial interpretations of sharia support risk management tools for genuine hedging (reducing risk) and where there is a clear link to an underlying asset. This has given rise to a fledgling OTC Islamic derivatives market with the most common transactions being swaps and index-linked derivatives. Equity investment is permitted – indeed it falls clearly within sharia principles of risk-and-reward sharing but with restrictions on the types of business that can be funded. Because of the demand for sharia-complaint equity investments, a number of Islamic market indices have been launched as benchmarks on western markets such as the New York and London stock exchanges.
London is the market leader in Europe for Islamic finance and claims to offer a substantial cluster of expertise in the city, with over 25 banks, 10 fund managers and several international law firms with specialist Islamic banking practices. The UK is the only western country that features in the top 10 list of countries with the largest amount of Sharia-complaint assets ($10 billion). By contrast, New York is a small and insignificant player with, so far, little appetite from its investors for sharia products. Dubai is the hub of the Islamic banking world, followed by Bahrain. Beyond the gulf, Malaysia and Singapore are the largest centres for sharia finance. Malaysia dominates the sukuk (bond) market, accounting for an estimated two-thirds of the worldwide market